People want change - that's why so many voted for Obama. But as Newsweek's Evan Thomas admitted:

By definition, establishments believe in propping up the existing order. Members of the ruling class have a vested interest in keeping things pretty much the way they are. Safeguarding the status quo, protecting traditional institutions, can be healthy and useful, stabilizing and reassuring....

"If you are of the establishment persuasion (and I am). . . ."

In other words, many editors, publishers, producers and reporters think of themselves as being part of the establishment class, and so do everything they can to protect those in power.

On the other hand, as I wrote a year ago, it is possible to get direct-from-source news on the web:

Many of the world's top PhD economics professors and financial advisors have their own blogs...

The same is true in every other field: politics, science, history, international relations, etc.

So what is "news"? What the largest newspapers choose to cover? Or what various leading experts are saying - and oftentimes heatedly debating one against the other?

And as award-winning investigative journalist Jeremy Scahill said recently:

I think we're in a moment where corporations are more dominant over newsgathering and news production and disseminating information than they've ever been.

Contrary to that, though, you also have this sort of "citizen journalism" rising up, where you have people that are staring their own blogs or their own web sites.

So the blogosphere is certainly vital.

A Waste of Time

On the other hand, even with all of the millions of bloggers exposing what's going on, the powers-that-be are ignoring us.

Even with high-level economics and financial experts demonstrating that the economy cannot recover until the big banks are broken up, the government is letting them get bigger and bigger. For example, an all-star cast of well-known experts says that we must break up the big banks, with people like Simon Johnson blogging about this daily for one of the world's most popular news sites (Huffington Post). And yet nothing is changing.

Even with top security experts showing that the never-ending "war on terror" is harming our national security, and that covering up for the torturers and war criminals is making us less safe, the Obama administration is continuing the never-ending war, and has swept torture and war crimes under the rug.

I could go on and on, but if you've been paying any attention, you know that our country is headed in the wrong direction, no matter how many thoughtful writers point out the direction we should be headed.

Moreover, the blogsphere is not a "free market" of ideas. Whistleblowers and many of the hardest-hitting blog posts get attacked or buried by the powers-that-be. Because of this censorship, there may be a highly educated minority of millions of Americans, but the majority still gets their news from the mainstream media, including the mainstream news websites.

So blogging may be doing nothing but blowing off steam, and draining the energy which should be used for massive protests and strikes. Indeed, maybe we are just shouting within the Matrix, in an artificial environment. Maybe we are having as much effect as protesters in government-approved "protest zone" - miles from the media, let alone the real events they are protesting.

Knowing stuff isn't enough. Being smart isn't enough. Indeed, being informed and smart but failing to take action to protect ourselves is a recipe for disaster (and perhaps even extinction).

Noam Chomsky has previously written that he would submit to fascism if it would help combat global warming:

Suppose it was discovered tomorrow that the greenhouse effects has been way understimated, and that the catastrophic effects are actually going to set in 10 years from now, and not 100 years from now or something. Well, given the state of the popular movements we have today, we'd probably have a fascist takeover-with everybody agreeing to it, because that would be the only method for survival that anyone could think of. I'd even agree to it, because there's just no other alternatives right now."

And James Lovelock - environmentalist and creator of the "Gaia hypothesis" - recently told the Guardian:

We need a more authoritative world. We've become a sort of cheeky, egalitarian world where everyone can have their say. It's all very well, but there are certain circumstances – a war is a typical example – where you can't do that. You've got to have a few people with authority who you trust who are running it. And they should be very accountable too, of course.

But it can't happen in a modern democracy. This is one of the problems. What's the alternative to democracy? There isn't one. But even the best democracies agree that when a major war approaches, democracy must be put on hold for the time being. I have a feeling that climate change may be an issue as severe as a war. It may be necessary to put democracy on hold for a while.

Whatever you think of climate change - whether you think we need to cool the planet or not - one thing is for sure ...

Monday, March 29, 2010

On March 3rd, Richard Fisher - President of the Federal Reserve Bank of Dallas - told the Council on Foreign Relations:

A truly effective restructuring of our regulatory regime will have to neutralize what I consider to be the greatest threat to our financial system’s stability—the so-called too-big-to-fail, or TBTF, banks. In the past two decades, the biggest banks have grown significantly bigger. In 1990, the 10 largest U.S. banks had almost 25 percent of the industry’s assets. Their share grew to 44 percent in 2000 and almost 60 percent in 2009.

The existing rules and oversight are not up to the acute regulatory challenge imposed by the biggest banks. First, they are sprawling and complex—so vast that their own management teams may not fully understand their own risk exposures. If that is so, it would be futile to expect that their regulators and creditors could untangle all the threads, especially under rapidly changing market conditions. Second, big banks may believe they can act recklessly without fear of paying the ultimate penalty. They and many of their creditors assume the Fed and other government agencies will cushion the fall and assume the damages, even if their troubles stem from negligence or trickery. They have only to look to recent experience to confirm that assumption.

Some argue that bigness is not bad, per se. Many ask how the U.S. can keep its competitive edge on the global stage if we cede LFI territory to other nations—an argument I consider hollow given the experience of the Japanese and others who came to regret seeking the distinction of having the world’s biggest financial institutions. I know this much: Big banks interact with the economy and financial markets in a multitude of ways, creating connections that transcend the limits of industry and geography. Because of their deep and wide connections to other banks and financial institutions, a few really big banks can send tidal waves of troubles through the financial system if they falter, leading to a downward spiral of bad loans and contracting credit that destroys many jobs and many businesses.

The dangers posed by TBTF banks are too great. To be sure, having a clearly articulated “resolution regime” would represent steps forward, though I fear they might provide false comfort in that a special resolution treatment for large firms might be viewed favorably by creditors, continuing the government-sponsored advantage bestowed upon them. Given the danger these institutions pose to spreading debilitating viruses throughout the financial world, my preference is for a more prophylactic approach: an international accord to break up these institutions into ones of more manageable size—more manageable for both the executives of these institutions and their regulatory supervisors. I align myself closer to Paul Volcker in this argument and would say that if we have to do this unilaterally, we should. I know that will hardly endear me to an audience in New York, but that’s how I see it. Winston Churchill said that “in finance, everything that is agreeable is unsound and everything that is sound is disagreeable.” I think the disagreeable but sound thing to do regarding institutions that are TBTF is to dismantle them over time into institutions that can be prudently managed and regulated across borders. And this should be done before the next financial crisis, because it surely cannot be done in the middle of a crisis.

Fisher joints many other top economists and financial experts believe that the economy cannot recover unless the big, insolvent banks are broken up in an orderly fashion, including:

The report was particularly scathing in its assessment of governments’ attempts to clean up their banks. “The reluctance of officials to quickly clean up the banks, many of which are now owned in large part by governments, may well delay recovery,” it said, adding that government interventions had ingrained the belief that some banks were too big or too interconnected to fail.

This was dangerous because it reinforced the risks of moral hazard which might lead to an even bigger financial crisis in future.

Senators Ted Kaufman, Maria Cantwell, John McCain and others are also demanding that the too big to fails be broken up.

But Senator Dodd is trying to push through a financial "reform" which bill won't do anything to break up the too big to fails, or do much of anything at all. It's got a reassuring name and a nice, sugary taste ... but there's no real medicine in it.

Saturday, March 27, 2010

The report is discussing apathy among the French and German people to their countries' involvement in the war in Afghanistan, but the same is true to the apathy of Americans towards the Iraq and other wars as well.

For a little background on the manipulation of public opinion, see this and this.

Allowed the giant banks to grow into mega-banks. For example, Citigroup's former chief executive says that when Citigroup was formed in 1998 out of the merger of banking and insurance giants, Greenspan told him, “I have nothing against size. It doesn’t bother me at all”

More importantly, as Nassim Taleb repeatedly points out, financial experts who don't plan for rare events are like pilots who don't know about storms.

There are storms out there, Taleb says, and any pilot who doesn't know how to deal with storms shouldn't be flying. Similarly, no one should be in a position of financial leadership if they don't know about - and plan for - the infrequent event:

Bill Gross is recommending that investors buy the debt of low-deficit countries. Via Business Week:

As Pacific Investment Management Co.’s Gross, manager of the world’s biggest bond fund, said yesterday in an interview with Tom Keene on Bloomberg Radio that [U.S.] “bonds have seen their best days.” Pimco, which announced in December that it would offer stock funds, is advising investors to buy the debt of countries such as Germany and Canada that have low deficits and higher- yielding corporate securities.

I am constantly asked where to find safe places to park cash by investors understandably unhappy with the risk/reward currently offered by the markets. Any reach for yield now carries substantial principal risk, the kind we saw, oh say, in the summer of 2007.

I have had great luck steering people into the Invesco PowerShares Emerging Market Sovereign Debt ETF (PCY) for the last nine months, which is invested primarily in the debt of Asian and Latin American government entities, and sports a generous 6.44% yield. This beats the daylights out of the one basis point you currently earn for cash, the 3.76% yield on 10 year Treasuries, and still exceeds the 4.70% yield on the iShares Investment Grade Bond ETN (LQD), which buys predominantly single “BBB”, or better, US corporates.

The big difference here is that PCY has a much rosier future of credit upgrades to look forward to than other alternatives. It turns out that many emerging markets have little or no debt, because until recently, investors thought their credit quality was too poor. No doubt a history of defaults in the region going back to 1820 is in the backs of their minds.

You would think that a sovereign debt fund would be the last place to safely park your money in the middle of a debt crisis, but you’d be wrong. PCY has minimal holdings in the Land of Sophocles and Plato, and very little in the other European PIIGS. In fact, the crisis has accelerated the differentiation of credit qualities, separating the wheat from the chaff, and sending bonds issues by financially responsible countries to decent premiums, while punishing the bad boys with huge discounts. It seems this fund has a decent set of managers at the helm.

With US government bond issuance going through the roof, the shoe is now on the other foot.

It should be noted that both Gross and the Hedge Trader are rather bullish on the U.S. economy. For example, one of the main reasons that Gross is now bearish on U.S. treasuries is because he is convinced the U.S. be hit with massive inflation. If he is wrong - and wrongdeflation reins for a while longer - then U.S. treasuries may still recover.

As to foreign sovereign debt, Ferguson, Faber and Grice apparently don't think that any country is safe. If they are right, that could argue for gold.

The recent rise in Treasury yields represents a “canary in the mine” that may signal further gains in interest rates.

Higher yields reflect investor concerns over “this huge overhang of federal debt which we have never seen before,” Greenspan said in an interview today on Bloomberg Television.

“I’m very much concerned about the fiscal situation,” said Greenspan, 84, who headed the central bank from 1987 to 2006. An increase in long-term interest rates “will make the housing recovery very difficult to implement and put a dampening on capital investment as well.”

The move up in [yield] coincides with the impending end of the Federal Reserve’s program to support the mortgage market. The Fed has bought $1.25 trillion of mortgage-backed securities, bolstering their prices and thus holding down their yields.

In just the past two days, the rate on 30-year Fannie Mae mortgage securities has risen to 4.5% from 4.3%. Once fees by lenders are tacked on, this means mortgage rates above 5%. Thomas Lawler, a housing economist, says some bigger lenders have already raised rates. Some were quoting 30-year mortgages at 5.125% Thursday morning, up from 4.875% earlier in the week, he said in a note to clients.

Concerns about the U.S. budget deficit are beginning to hurt the Treasury market, said Steve Rodosky, head of Treasury and derivatives trading at bond giant Pacific Investment Management Co. He said he is increasingly worried about the U.S. fiscal outlook.

Pacific Investment Management Co.’s Gross, manager of the world’s biggest bond fund, said yesterday in an interview with Tom Keene on Bloomberg Radio that “bonds have seen their best days.” Pimco, which announced in December that it would offer stock funds, is advising investors to buy the debt of countries such as Germany and Canada that have low deficits and higher- yielding corporate securities.

Here's a chart showing 10-year treasury yields over the last month, courtesy of Joe Weisenthal:

Thursday, March 25, 2010

Thomas M. Hoenig - president of the Federal Reserve Bank of Kansas City and the current longest-serving regional Fed chief - said in a speech at a U.S. Chamber of Commerce summit in Washington:

During the recent financial crisis, losses quickly depleted the capital of these large, over-leveraged companies. As expected, these firms were rescued using government funds from the Troubled Asset Relief Program (TARP). The result was an immediate reduction in lending to Main Street, as the financial institutions tried to rebuild their capital. Although these institutions have raised substantial amounts of new capital, much of it has been used to repay the TARP funds instead of supporting new lending.

On the other hand, Hoenig pointed out:

In 2009, 45 percent of banks with assets under $1 billion increased their business lending.

45% is about 45% morethan the amount of increased lending by the too big to fails.

This confirms my previous argument that the small banks will lend, if we stop the too big to fails from growing even bigger and stifling all competition:

Do we need to keep the TBTFs to make sure that loans are made?

Nope.

Fortune pointed out in February that smaller banks are stepping in to fill the lending void left by the giant banks' current hesitancy to make loans. Indeed, the article points out that the only reason that smaller banks haven't been able to expand and thrive is that the too-big-to-fails have decreased competition:

Growth for the nation's smaller banks represents a reversal of trends from the last twenty years, when the biggest banks got much bigger and many of the smallest players were gobbled up or driven under...

As big banks struggle to find a way forward and rising loan losses threaten to punish poorly run banks of all sizes, smaller but well capitalized institutions have a long-awaited chance to expand.

As big banks struggle, community banks are stepping in to offer loans and lines of credit to small business owners...

At a congressional hearing on small business and the economic recovery earlier this month, economist Paul Merski, of the Independent Community Bankers of America, a Washington (D.C.) trade group, told lawmakers that community banks make 20% of all small-business loans, even though they represent only about 12% of all bank assets. Furthermore, he said that about 50% of all small-business loans under $100,000 are made by community banks...

Indeed, for the past two years, small-business lending among community banks has grown at a faster rate than from larger institutions, according to Aite Group, a Boston banking consultancy. "Community banks are quickly taking on more market share not only from the top five banks but from some of the regional banks," says Christine Barry, Aite's research director. "They are focusing more attention on small businesses than before. They are seeing revenue opportunities and deploying the right solutions in place to serve these customers."

The importance of traditional financial intermediation services, and hence of the smaller banks that typically specialize in providing those services, tends to increase during times of financial stress. Indeed, the crisis has highlighted the important continuing role of community banks...

For example, while the number of credit unions has declined by 42 percent since 1989, credit union deposits have more than quadrupled, and credit unions have increased their share of national deposits from 4.7 percent to 8.5 percent. In addition, some credit unions have shifted from the traditional membership based on a common interest to membership that encompasses anyone who lives or works within one or more local banking markets. In the last few years, some credit unions have also moved beyond their traditional focus on consumer services to provide services to small businesses, increasing the extent to which they compete with community banks.

Indeed, some very smart people say that the big banks aren't really focusing as much on the lending business as smaller banks.

Specifically since Glass-Steagall was repealed in 1999, the giant banks have made much of their money in trading assets, securities, derivatives and other speculative bets, the banks' own paper and securities, and in other money-making activities which have nothing to do with traditional depository functions.

Now that the economy has crashed, the big banks are making very few loans to consumers or small businesses because they still have trillions in bad derivatives gambling debts to pay off, and so they are only loaning to the biggest players and those who don't really need credit in the first place. See this and this.

The Fortune article discussed above points out that the banking giants are not necessarily more efficient than smaller banks:

The largest banks often don't show the greatest efficiency. This now seems unsurprising given the deep problems that the biggest institutions have faced over the past year.

"They actually experience diseconomies of scale," Narter wrote of the biggest banks. "There are so many large autonomous divisions of the bank that the complexity of connecting them overwhelms the advantage of size."

And Governor Tarullo points out some of the benefits of small community banks over the giant banks:

Many community banks have thrived, in large part because their local presence and personal interactions give them an advantage in meeting the financial needs of many households, small businesses, and agricultural firms. Their business model is based on an important economic explanation of the role of financial intermediaries--to develop and apply expertise that allows a lender to make better judgments about the creditworthiness of potential borrowers than could be made by a potential lender with less information about the borrowers.

A small, but growing, body of research suggests that the financial services provided by large banks are less-than-perfect substitutes for those provided by community banks.

It is simply not true that we need the mega-banks. In fact, as many top economists and financial analysts have said, the "too big to fails" are actually stifling competition from smaller lenders and credit unions, and dragging the entire economy down into a black hole.

Hoenig also pointed out in numerous other ways that the too big to fails have to shrink or financial crises will keep on happening.

The indications are that some version of the Dodd bill will be presented to Democrats and Republicans alike as a fait accompli - this is what we are going to do, so are you with us or against us in the final recorded vote?

***

Of course, officials are lining up to solemnly confirm that "too big to fail" will be history once the Dodd bill passes.

But this is simply incorrect.

***

Why exactly do you think big banks, such as JP Morgan Chase and Goldman Sachs, have been so outspoken in support of a "resolution authority"? They know it would allow them to continue not just at their current size - but actually to get bigger. Nothing could be better for them than this kind of regulatory smokescreen. This is exactly the kind of game that they have played well over the past 20 years - in fact, it's from the same playbook that brought them great power and us great danger in the run-up to 2008.

When a major bank fails, in the years after the Dodd bill passes, we will face the exact same potential chaos as after the collapse of Lehman. And we know what our policy elite will do in such a situation - because Messrs. Paulson, Geithner, Bernanke, and Summers swear up and down there was no alternative, and people like them will always be in power. If you must choose between collapse and rescue, US policymakers will choose rescue every time - and probably they feel compelled again to concede most generous terms "to limit the ultimate cost to the taxpayer" (or words to that effect).

The banks know all this and will act accordingly. You do the math.

Once you understand that the resolution authority is an illusion, you begin to understand that the Dodd legislation would achieve nothing on the systemic risk and too big to fail front.

On reflection, perhaps this is exactly why the sponsors of this bill are afraid to have any kind of open and serious debate. The emperor simply has no clothes.

Indeed, Johnson has previously said that recovery will fail unless we break the financial oligarchy that is blocking essential reform, and he has called the U.S. a banana republic.

Congress and the White House won't do anything to stand up to the oligarchs because they are fully bought and paid for . The oligarchy is trying to make us serfs, and our politicians (with a few notable exceptions) are helping.

Remember, it is the government which created the too big to fails. Now, politicians are covering for them with legislation that sounds good ... but really just helps the too big to fails get even bigger.

[One region of space] has such a massive gravitational pull, that it is pulling our entire galaxy and all of the nearby galaxies towards it at the speed of 1,000,000 miles an hour ...

We don't feel any movement because everything on Earth and in our galaxy is moving at the same speed. In other words, we don't feel the movement for the same reason that we don't feel the Earth rotate: everything around us is rotating at the same time.

Back to National Geographic:

This mysterious motion can't be explained by current models for distribution of mass in the universe. So the researchers made the controversial suggestion that the clusters are being tugged on by the gravity of matter outside the known universe.

Now the same team has found that the dark flow extends even deeper into the universe than previously reported: out to at least 2.5 billion light-years from Earth.

After using two additional years' worth of data and tracking twice the number of galaxy clusters, "we clearly see the flow, we clearly see it pointing in the same direction," said study leader Alexander Kashlinsky, an astrophysicist at NASA's Goddard Space Flight Center in Maryland.

"It looks like a very coherent flow."

The find adds to the case that chunks of matter got pushed outside the known universe shortly after the big bang—which in turn hints that our universe is part of something larger: a multiverse.

***

The new study is based on the collective motion of about 1,400 galaxy clusters, and seeing dark flow with the greater number of clusters gives the researchers more confidence in their result.

***

Kashlinsky speculates that the dark flow extends "all the way across the visible universe," or about 47 billion light-years, which would fit with the notion that the clusters are being pulled by matter that lies beyond known horizons.

Dark flow, he said, "would be much more difficult to explain theoretically if it extended [2.5 billion light-years] and then just stopped."

Note: An earlier National Geographic story makes it clear that the dark matter is only mysterious because it lies outside the boundary of the "known universe", in reference to the big bang:

Current models say the known, or visible, universe—which extends as far as light could have traveled since the big bang—is essentially the same as the rest of space-time (the three dimensions of space plus time).

Michael Rivero, who doesn't buy into the big bang theory, argues that - instead of this evidence proving that we live in a multiverse - it may instead disprove the big bang. As Rivero writesin response to my essay:

What the evidence reported in the story is showing is that there is enough matter to create a gravity field detectable in the motions of the galaxies we can see from Earth, but the gravity field points to a source well outside the presumed edge of the universe which has been calculated from the observed red shift, which is assumed to be caused solely by relative velocity. But since the prime assumption is that our "banged" universe cannot reach that far, that there simply must be a wholly separate universe out there. Of curse, since "universe" means "all that there is", whatever is out there creating this gravity field is by definition part of this universe, which creates a paradox for the Big Bangers.

But here is another one that I postulated some time back for which no banger has yet had an answer.

When we gaze out into the night sky, we see galaxies extending into the distance as far as we can see, in every direction. The presumed size of the universe (and its age) keep getting revised as more distant objects get detected, but here it the problem. If the universe is finite, it should appear lopsided. In one direction we should see the end of the universe much more closely than the opposite direction, unless the Earth just happened to be in the exact center of that universe, and of course the odds against that are (pardon the expression) astronomical!

***

The fact is that this latest discovery puts the final nail in the Big Bang model, even though the die-hard bangers will refuse to see it.

Three stories from the Wall Street Journal hint at bad news for the U.S.

Michael Casey notes that American CDS traders view the U.S. as riskier than Europe:

Something troubling has occurred in the market for default protection on the debt of the world's biggest borrower.

As the folks at Standard Poor's Valuation and Risk Strategies division noted in a research note Monday, the difference between the spread on U.S. sovereign credit default swaps and an equivalent benchmark for AAA-rated euro-zone sovereigns flipped into positive territory March 12. As U.S. CDS spreads expanded to their widest levels in two years, that cross-region gap blew out to 5.7 basis points last Friday before narrowing to 4.7 Tuesday.

Wider CDS spreads indicate that sellers of insurance against a particular issuer's default are charging more for it. In effect, the positive U.S.-versus-euro zone spread means investors think the risk of a U.S. default--however remote--is greater than that on euro-denominated sovereign debt.

So much for the view that low inflation and loose monetary policy make for a rosier debt outlook for Treasurys than for the debt of crisis-hit euro-zone sovereigns.

"We've seen CDS on U.S. Treasurys break with euro CDS before, but never to the degree we have here," said Michael Thompson, head of research for S&P's Valuation and Risk Strategies group. "If we sit on this precipice for a time, I think a lot of market participants would see this as a bit of a shot across the bow, a bit of a wakeup" for anyone who's complacent about U.S. debt.

Wouldn't it also challenge U.S. Treasurys' status as the so-called "risk free" benchmark? S&P didn't go there. But the report did say the trend "reflects increasing market anxiety surrounding the U.S.'s credit quality." In other words, a fiscal deficit worth 10% of gross domestic product--in the absence of a clear plan to reduce it -- matters.

***

Short-term moves of a basis point or two can be attributed to technical factors, but such a lasting shift in the two regions' CDS relationship "is not technical," Mr. Thompson said. "I certainly wouldn't ignore it."

Thompson's team also noted that the deterioration in U.S. default swaps meant that S&P's "market-derived signal" dropped to 'aa+,' its lowest level in two years. The historical series for that indicator is based on an established correlation with actual S&P ratings.

There's no indication that S&P's separate ratings division is about to downgrade the U.S. 's vital 'AAA' rating. But over time, ratings analysts cannot stay blind to market signals like this one. As its weighs the stimulus needs of a still-fragile U.S. economy against future risks to debt servicing costs, the U.S. government can't ignore market signals either.

Treasury prices fell hard after a poor five-year auction that escalated concerns about the government's ability to sell its massive amounts of debt.

Worries about supply picked up this week after the government's $44 billion two-year auction on Tuesday attracted less demand than anticipated. The five year sale was messier, sending Treasury prices tumbling. Demand at the auctions may have been impacted by less buying from Japan as its fiscal year-end approaches. Nonetheless, the poor results put investors on edge given the huge amounts of debt the government is likely to continue to issue to fund its budget deficit.

Investors were reminded of the huge amounts of debt the government will need to continue to sell after President Barack Obama signed into law a $940 billion health-care overhaul bill on Tuesday, which will necessitate even more borrowing by the government.

"We're going to continue to see massive amounts of supply in Treasury-land," said Brian Edmonds, head of interest rates at Cantor Fitzgerald & Co. in New York.

***

It was an "ugly auction," said Ward McCarthy, managing director of the fixed-income division at Jefferies & Co. "You're starting to see a bit of a Treasury market protest. There's a very legitimate concern that Washington is pushing the envelope too far in terms of the U.S.'s ability to carry all this debt."

Some observers fear that the market is finally starting to show the strain of absorbing a record flood of new Treasury issuance. One sign of that could be the unusual crossing of swap rates below Treasury yields, which could signal that investors see corporate debt as safer than Treasury debt.

"This is a first sign of stress leading to higher Treasury yields and is not to be missed," James Caron, head of U.S. interest-rate strategy at Morgan Stanley, said in a note to clients.

Wednesday, March 24, 2010

The Wall Street Journal ran an editorial last August pointing out that the American people are just about the only ones fooled by the government's use of off-balance sheet, SIV-type accounting to hide the debts of Fannie, Freddie, Social Security and Medicare:

The bigger issue is that all of Fan[nie] and Fred[ie]'s liabilities, whether kept inside the companies or hidden in a dark corner of the Treasury, are now Uncle Sam's responsibility. Moving their bad assets into a new Baddie Mae would only preserve the fiction that there is a difference between the government's obligations and those of Fan and Fred. Not even Barney Frank could believe that any more.

***

For the moment, despite 80% government ownership, their $85 billion bailout cost (with more losses to come) and their $5.4 trillion in taxpayer liabilities remain off-balance-sheet in the mold of Enron's special purpose vehicles or Citigroup's SIVs.

The politicians who created and pampered Fan and Fred like it that way. They know that offering federal "guarantees" looks much cheaper, in the official accounting, than actual outlays. But whether it's Fan and Fred, or the Pension Benefit Guaranty Corporation or the Federal Housing Administration, these deferred promises seem to come due sooner or later. Perhaps the politicians would be less profligate in issuing such guarantees if they had to admit the cost up front.

Putting Fannie and Freddie on the national books would in an instant increase the national debt held by the public by 75%—to $12.7 trillion, from $7.3 trillion today. The nearby chart shows that this takes debt as a share of GDP to nearly 90%, or nearly double the peak it reached in the 1980s when the political class was hyperventilating even as the Reagan deficits were falling as a share of GDP. Congress would have to add that $5.4 trillion to the increase in the federal debt limit that Treasury Secretary Timothy Geithner is now requesting. But that would be truth-in-budgeting. Wall Street has sold Fannie paper to the world as if it were as taxpayer guaranteed as Treasury bills, and now we know it is.

Even as the companies careened toward failure a year ago, the Bush Administration was desperate to show it would cover all Fan and Fred debt. The Obama Treasury has been no different and has ginned up the two companies to expand their debts amid the housing meltdown by guaranteeing more residential mortgages. The Federal Reserve has bought $543 billion of Fannie and Freddie mortgage-backed securities and has plans to buy up to $1.25 trillion worth by year end. Foreign debt holders get the message. The only people who still might be fooled are the American taxpayers, who are ultimately responsible when the bills come due.

The larger issue is the integrity of the national balance sheet. As government spending soars, the political temptation to use off-balance-sheet vehicles of various sorts will only increase. Barney Frank is even pushing a bill to make the feds guarantee U.S. municipal debt. The danger is that the federal government will itself become the next Enron, with its biggest liabilities hidden from view, officially denied or tucked away in special purpose vehicles like Fannie Mae. Until the next crisis hits.

It's bad enough that the political class has played this dishonest game with the long-term liabilities of Social Security and Medicare, which are also kept off the balance sheet. But at least those IOUs are held by another branch of the government and can be legislated away by some future Congress. Debt held by the public can't be repudiated without the U.S. descending into Argentina-ville. It's time to come clean about the debts our government is racking up, and Fannie and Freddie are a good place to start.

A team of scientists has succeeded in putting an object large enough to be visible to the naked eye into a mixed quantum state of moving and not moving.

***Through a phenomenon known as 'superposition' a particle can be moving and stationary at the same time — at least until an outside force acts on it. Then it instantly chooses one of the two contradictory positions.

But although the rules of quantum mechanics seem to apply at small scales, nobody has seen evidence of them on a large scale, where outside influences can more easily destroy fragile quantum states. "No one has shown to date that if you take a big object, with trillions of atoms in it, that quantum mechanics applies to its motion," Cleland says.

There is no obvious reason why the rules of quantum mechanics shouldn't apply to large objects.

Note: Science and Nature are two of the most reputable mainstream science journals.

Federal Housing Administration head David Stevens said recently that no one trusts the housing finance system. As the Washington Post writes:

In a recent speech, David Stevens, the FHA's commissioner, recalled meeting a group of international bankers who "peppered me with questions - very difficult questions" about what the U.S. government was doing to bring back their trust.

They all have been burned, he noted, after buying mortgage securities with triple-A ratings that turned out to be junk.

"We are at the point right now," Stevens said, "where no one trusts the American housing finance system."

Of course, the government couldn't let housing prices adjust to a sustainable, non-bubble level. As US News and World Report points out:

Most economists feel the economy won’t rebound until housing prices bottom out and stabilize.

The value of mortgage backed securities and derivative products based on these securities cannot be accurately valued unless there is a high level of confidence in the value of our housing stock. A big concern about the implementation of the TARP is what the government will pay for these toxic securities. If we know what houses are worth, it will be easier to determine fair market value of the securities.

Tuesday, March 23, 2010

Tim Geithner told the House Financial Services Committee today that txpayers are likely to face "very substantial" losses from the government's takeover of home mortgage giants Fannie Mae and Freddie Mac.

Taxpayers have pumped more than $125 billion into the failed firms -- and on the hook for many more after the administration promised an unlimited source of funds just before Christmas to backstop their growing losses.

And as Nasiripour points out, Geithner has absolutely no idea how to fix Fannie or Freddie.

The Bank for International Settlements (BIS) is often called the "central banks' central bank", as it coordinates transactions between central banks.

BIS points out in a new report that the bank rescue packages have transferred significant risks onto government balance sheets, which is reflected in the corresponding widening of sovereign credit default swaps:

The scope and magnitude of the bank rescue packages also meant that significant risks had been transferred onto government balance sheets. This was particularly apparent in the market for CDS referencing sovereigns involved either in large individual bank rescues or in broad-based support packages for the financial sector, including the United States. While such CDS were thinly traded prior to the announced rescue packages, spreads widened suddenly on increased demand for credit protection, while corresponding financial sector spreads tightened.

In other words, by assuming huge portions of the risk from banks trading in toxic derivatives, and by spending trillions that they don't have, central banks have put their countries at risk from default.

Grice also says:

Eventually, there will be a crisis of such magnitude that the political winds change direction, and become blustering gales forcing us onto the course of fiscal sustainability. Until it does, the temptation to inflate will remain, as will economists with spurious mathematical rationalisations as to why such inflation will make everything OK . Until it does, the outlook will remain favorable for gold. But eventually, majority opinion will accept the painful contractionary medicine because it will have to. That will be the time to sell gold.

Monday, March 22, 2010

In a command economy, the government decides what numbers it wants, and then instructs its economists and government agencies to arrive at those numbers.

If they don't, they're killed or thrown into prison.

So when China's official daily newspaper - China Daily - writes that China will probably run a trade DEFICIT in March, it is hard to know if it is real.

Indeed, it seems suspicious that China Daily linked the deficit in the same opening sentence with America's threats to label China a currency manipulator:

The country will probably see a "record trade deficit" in March thanks to surging imports, Minister of Commerce Chen Deming said on Sunday, while warning that Beijing will "fight back" if Washington labels China a currency manipulator.

Speaking at the three-day China Development Forum that ends on Monday, Chen said: "I believe there will be a trade deficit in March" - which will be the first since May 2004.

And this comes hot on the heels of tremendous pressure from both the House and Senate on China to revalue its currency.

So it is tempting to assume that this is just a blunt effort to get the U.S. to back down on its efforts to revalue the Yuan.

However, as Société Générale's Albert Edwards wrote on March 2nd (via Zero Hedge): this critical shift:

Clearly to the extent that the rise in China's official reserves depended on the size of its trade deficit, there will be reduced purchases of US Treasuries. But China has, in part, merely been swapping official dollar purchases of US Treasuries with surging imports of dollar-denominated commodities on the trade account (see chart below).

In other words, China's huge purchases of commodities from Australia, Brazil and elsewhere have overtaken exports.

So it looks like the trade deficit might be real.

But even if it isn't, it shows that the entire environment everyone assumes we are operating in - China as the giant net exporter with huge trade surpluses - might not continue for much longer. In other words, "Chimerica" is starting to break up.

Public distrust of bankers and financial markets has risen dramatically with the financial crisis. This column argues that this loss of trust in the financial system played a critical role in the collapse of economic activity that followed. To undo the damage, financial regulation needs to focus on restoring that trust.

They note:

Trust is crucial in many transactions and certainly in those involving financial exchanges. The massive drop in trust associated with this crisis will therefore have important implications for the future of financial markets. Data show that in the late 1970s, the percentage of people who reported having full trust in banks, brokers, mutual funds or the stock market was around 40%; it had sunk to around 30% just before the crisis hit, and collapsed to barely 5% afterwards. It is now even lower than the trust people have in other people (randomly selected of course).

In other words, people now trust bankers less than random people on the street.

They point out:

Trust was destroyed in large measure by the revelation of opportunistic behaviour that the crisis brought to light, of which the Bernard Madoff case is emblematic. Indeed, the data examined shows that in states where the number of Madoff victims was higher, the level of trust towards bankers, brokers and mutual funds has fallen more than in those states with a lower concentration of Madoff victims.

The dark light this has cast on the whole financial industry will most likely result in:

A drop in investment in risky assets, as such assets lend themselves more easily to opportunistic behaviour than simple securities. This will bias portfolios markedly towards safer securities and away from stocks.

A drop in demand for complex financial instruments with uncertain returns. Given that such instruments’ complexity exposes them more easily to fraud, a higher dose of trust is required for investors to hold them. If trust is absent, investors will turn to more familiar securities.

Turning to more familiar assets will increase the share of domestic assets in portfolios, making them somewhat less diversified. On the other hand, investors will tend to diversify their stable of intermediaries, in order to reduce their exposure to any one in particular. Both effects are costly, as the first entails losing the benefits of diversification and the second involves higher costs from setting and maintaining multiple relations.

A corollary of the above will be less reliance on and delegation to intermediaries, given that a fundamental ingredient in the intensity of financial delegation is the level of investor’s trust. Since delegation is more necessary the more sophisticated the security, this will also fuel a move towards simpler portfolios.

Lastly, since an insurance contract is also a financial contract, the fall in trust should also affect the demand for insurance.

In sum, the dearth of trust towards all segments of the financial industry will give rise to a generalised flight from financial trades, in particular from those more exposed to opportunistic behaviour.

The shift to safer assets will push up the equity premium, affecting the type of firms that depend on raising equity for their financing. If this preference also means that longer-maturity instruments will be shunned in favour of short-term ones, it will raise the cost of longer-term financing, hampering projects with longer maturities.

[A bank can be defined as a] third party whose record-keeping is trusted by all parties as recording the transfers of credit money that effect sales of commodities...

In a fundamental way, a bank is a bank because it is trusted. Of course, as we know from our current bitter experience, banks can damage that trust; but it remains the wellspring from which their existence arises.

Part of the reason that the campaign for people to move their money to smaller banks.

Given that the TBTFs have cooked their books every which way, it is not surprising that millions of Americans are moving their money to local banks and credit unions and campaigning for public banking.

For example, here is the search volume for the phrase "public banking" over the last 3 years:

Of course, banks could be untrustworthy in regards to some things - such as valuing their assets, keeping hundreds of billions of dollars worth of liabilities hidden in off-balance sheet sivs, using Repo 105s and other gimmicks to misrepresent their financial health, and doing things like pushing investments to their mom and pop clients while shorting those same investments - and yet be honest in processing normal depository transactions.

But most people are not going to trust a convicted house burglar to prepare their taxes, even though tax-preparation is different from physical burglary.

The distinguished international group of economists suggest various ways to restore trust in banks. But they miss the core truth: trust will not be restored unless the fraud is actually stopped.

But instead of trying to stop the fraud and prosecute the con artists who got us into this mess, Summers, Bernanke, Geithner and the rest of the boys are doing everything they can to cover it up and protect their buddies on Wall Street.

And in doing so, they are destroying the people's trust not only in Wall Street, but in the government, as well.

Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $100 deposit may lend out $90 of that deposit. If the borrower then writes a check to someone who deposits the $90, the bank receiving that deposit can lend out $81. As the process continues, the banking system can expand the initial deposit of $100 into a maximum of $1,000 of money ($100+$90+81+$72.90+...=$1,000). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $100 deposit into a maximum of $500 ($100+$80+$64+$51.20+...=$500). Thus, higher reserve requirements should result in reduced money creation and, in turn, in reduced economic activity.

Let's see how the fractional-reserve process works, in the absence of a central bank. I set up a Rothbard Bank, and invest $1,000 of cash (whether gold or government paper does not matter here). Then I "lend out" $10,000 to someone, either for consumer spending or to invest in his business. How can I "lend out" far more than I have? Ahh, that's the magic of the "fraction" in the fractional reserve. I simply open up a checking account of $10,000 which I am happy to lend to Mr. Jones. Why does Jones borrow from me? Well, for one thing, I can charge a lower rate of interest than savers would. I don't have to save up the money myself, but can simply counterfeit it out of thin air. (In the 19th century, I would have been able to issue bank notes, but the Federal Reserve now monopolizes note issues.) Since demand deposits at the Rothbard Bank function as equivalent to cash, the nation's money supply has just, by magic, increased by $10,000. The inflationary, counterfeiting process is under way.

"Unfortunately, while banks depend on the warehouse analogy, the depositors are systematically deluded. Their money ain't there."

The 19th-century English economist Thomas Tooke correctly stated that "free trade in banking is tantamount to free trade in swindling." But under freedom, and without government support, there are some severe hitches in this counterfeiting process, or in what has been termed "free banking."

But second, even if I were trusted, and I were able to con my way into the trust of the gullible, there is another severe problem, caused by the fact that the banking system is competitive, with free entry into the field. After all, the Rothbard Bank is limited in its clientele. After Jones borrows checking deposits from me, he is going to spend that money. Why else pay for a loan? Sooner or later, the money he spends, whether for a vacation, or for expanding his business, will be spent on the goods or services of clients of some other bank, say the Rockwell Bank. The Rockwell Bank is not particularly interested in holding checking accounts on my bank; it wants reserves so that it can pyramid its own counterfeiting on top of cash reserves. And so if, to make the case simple, the Rockwell Bank gets a $10,000 check on the Rothbard Bank, it is going to demand cash so that it can do some inflationary counterfeit pyramiding of its own.

But, I, of course, can't pay the $10,000, so I'm finished. Bankrupt. Found out. By rights, I should be in jail as an embezzler, but at least my phoney checking deposits and I are out of the game, and out of the money supply.

Hence, under free competition, and without government support and enforcement, there will only be limited scope for fractional-reserve counterfeiting. Banks could form cartels to prop each other up, but generally cartels on the market don't work well without government enforcement, without the government cracking down on competitors who insist on busting the cartel, in this case, forcing competing banks to pay up...

Hence the drive by the bankers themselves to get the government to cartelize their industry by means of a central bank.

Whenever instability turns up, we see efforts to socialize the losses, but rarely do people question the source of instability. Economist Jesús Huerta de Soto places the blame on the institution of fractional-reserve banking. This is the notion that depositors’ money in use as cash may also be loaned out for speculative projects, then re-deposited. The system works as long as people do not attempt to withdraw their money all at once. In the face of such a demand, banks turn to other banks to provide liquidity. But when the failure becomes system-wide, they turn to government.

The core of the problem is the conglomeration of two distinct functions of a bank. The first is warehousing, whereby banks keep money safe and provide checking, ATM access, record keeping, and online payment, services for which consumers are traditionally asked to pay. The second service the bank provides is a loan service, seeking out investments and putting money at risk in search of return.

The institution of fractional reserves mixes these functions, such that warehousing becomes a source for lending. The bank loans out money that has been warehoused—and stands ready to use in checking accounts or other forms of checkable deposits—and that loaned money is deposited yet again in checkable deposits. It is loaned out again and deposited, with each depositor treating the loan money as an asset on the books. In this way, fractional reserves create new money, pyramiding it on a fraction of old deposits. An initial deposit of $1,000, thanks to this “money multiplier,” turns into $10,000. The Fed adds reserves to the balances of member banks in the hope of inspiring ever more lending.

As customers, we believe that we can have both perfect security for our money, withdrawing it whenever we want and never expecting it not to be there, while still earning a return on that same money. In a true free market, however, there tends to be a tradeoff: you can enjoy the service of a warehouse or loan your money and hope for a return. The Fed, by backing up fractional-reserve banking with a promise of endless bailouts and money creation, attempts to keep the illusion going.

The history of banking legislation can be seen as an elaborate attempt to patch the holes in this leaking boat. Thus have we created deposit insurance, established the “too-big-to-fail” doctrine, and approved schemes for emergency injections to keep an unstable system afloat .

And at least some people claim that the fractional reserve banking system is guaranteed to create unsustainable levels of debt.

From Fractional to Fictional Reserves

But whatever you think about fractional reserve banking, whether or not you agree with its critics, the truth is that we no longer have it.

As the above-linked NY Fed article notes:

In practice, the connection between reserve requirements and money creation is not nearly as strong as the exercise above would suggest. Reserve requirements apply only to transaction accounts, which are components of M1, a narrowly defined measure of money. Deposits that are components of M2 and M3 (but not M1), such as savings accounts and time deposits, have no reserve requirements and therefore can expand without regard to reserve levels.

The US Federal Reserve sets a Required Reserve Ratio of 10%, but applies this only todeposits by individuals; banks have no reserve requirement at all for deposits by companies.

So huge swaths of loans are not subject to any reserve requirements.

With the repeal of Glass-Steagall, deposits have been used to speculate in every type of investment under the sun, using insane amounts of leverage. Instead of the traditional 10-to-1 ratio, the giant banks and hedge funds were using much higher levels of leverage.

For example, Congresswoman Kaptur told Bill Moyers that while - on paper - there are 10-to-1 reserve requirements, banks like JP Morgan were using 100 to 1 leverage. She said that, with derivatives, leverage might be much higher.

And remember that most of the credit in our economy is actually through the shadow banking system, not through traditional depository banking.

“Before last fall’s financial crisis, banks provided only $8 trillion of the roughly $25 trillion in loans outstanding in the United States, while traditional bond markets provided another $7 trillion, according to the Federal Reserve. The largest share of the borrowed funds - $10 trillion - came from securitized loan markets that barely existed two decades ago. . . .

Mr. Regalia [chief economist at the U.S. Chamber of Commerce] said ... 70 percent of the system isn’t there anymore,’ he said.”

Bernanke, Summers, Geithner and the boys have been working as hard as they can to re-start the shadow banking system, and traditional loans to individuals and small businesses have plummeted. So the percentage of shadow banking system lending to the all lending has probably skyrocketed again.

The NY Fed continues:

Furthermore, the Federal Reserve operates in a way that permits banks to acquire the reserves they need to meet their requirements from the money market, so long as they are willing to pay the prevailing price (the federal funds rate) for borrowed reserves. Consequently, reserve requirements currently play a relatively limited role in money creation in the United States.

In other words, as we've repeatedly written, reserves can be obtained once a binding loan commitment is made.

As William C. Dudley, President and Chief Executive Officer of the Federal Reserve Bank of New York, said in a speech last July:

Based on how monetary policy has been conducted for several decades, banks have always had the ability to expand credit whenever they like. They don’t need a pile of “dry tinder” in the form of excess reserves to do so. That is because the Federal Reserve has committed itself to supply sufficient reserves to keep the fed funds rate at its target. If banks want to expand credit and that drives up the demand for reserves, the Fed automatically meets that demand in its conduct of monetary policy. In terms of the ability to expand credit rapidly, it makes no difference.

The Federal Reserve believes it is possible that, ultimately, its operating framework will allow the elimination of minimum reserve requirements, which impose costs and distortions on the banking system.

And - according to Steve Keen - about 6 OECD countries have already done away with reserve requirements altogether (Keen confirmed that Australia requires no reserves; I know that Mexico doesn't require reserves; and Canad, New Zealand, Sweden and the UK supposedly require no reserves as well).

How Can An Insolvent Company Have Any Reserves?

Everyone knows that banks are required to have reserves, and that the giant banks supposedly have massive sums of excess reserves.

But does that really mean anything when everyone who runs the numbers says that the giant banks are (once again) insolvent?

Specifically, if we took away mark-to-the-moon valuations, forced the big boys to put their SIV off-sheet liabilities back onto their balance sheets, and stopped all of the fraud, spinning and other hanky-panky (of which Lehman's Repo 105s were just a tiny part), it would be obvious that the too big to fails were deeper into the hole than Wiley Coyote after he fell of the cliff and hit the ground.

So any "reserves" that the TBTFs have are fake, courtesy of the taxpayer, Uncle Sugar, and plain old puppetry .

We no longer have a fractional reserve banking system. Reserves are just a fiction.

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